In Part IV of the series of reports from the 10th
annual Strategic Investment Conference, presented by Altegis
Investments and John
Mauldin, Mohamed El-Erian ties together the views of the
previous presenters. You can read the previous presentations by
clicking the links below.

Mohamed El-Erian, Ph.D. is the CEO and Co-CIO for Pimco, the
global investment company with over $2 Trillion in assets under
management. Here are his views:

I want to try and build on what you have heard so
far. I want to focus, in particular, on two
statements that have been made so far at this conference.

The need to put the pieces together

Tomake sure we give ourselves a
chance to win.

So, how do we put the pieces together to give us the best chance
to win? I will try and give you an answer.

If you knew nothing of the markets, and just showed up at this
conference, you would be very confused. The world is awash in
contradiction with stocks rising to new highs as interest rates
reflect a slowing economy. It is an upside down world.

Individuals are both excited and anxious. They are excited by the
rally in the markets as they see their portfolios increase in
values but at the same timed overwhelmingly concerned about the
economic future. It is a world with an enormous contrast between
the markets and the real economy. That is the world we are
navigating and it is incredibly unusual. This is why it is an
unloved rally.

Therefore, I want to provide a simple framework to reconcile
these issues. The long term view matters greatly - but the short
term matters also.

First, acknowledge that we are here, in terms of current policy,
for a good reason. Most countries are shifting from a growth
model based on leverage and credit creation to trying to find a
new growth model based on new realities. Emerging markets are
shifting from exports to internal growth. Developed economies are
shifting to a lower growth economic cycle due to ongoing
deleveraging.

These shifts require assistance from the Central Banks. However,
this assistance leads to disconnects.

"The question, however, is what the “hand off” from
assisted support to organic growth will look like and when will
it come?"

"The hand off is the 'destination.' The 'journey' is
getting there. Investors must invest for both the journey AND
the destination. Investing for only one part will lead to
unhappiness during the journey or pain at the
destination."

At Pimco this reality is what we call the “stable
disequilibrium.” The world will not reset in cyclical
manner and a “new normal” has arrived.

The look of the “new normal” is that the West will be
stuck in a low growth and high unemployment cycle for quite some
time to come. Conversely, the emerging world will continue to
bounce back and begin to close the gap between wealth and
incomes.

There are three speeds to the “new normal.”

Slow: Europe and Japan that will live
continue to live through lost decades.

Medium: Countries like the US are
healing - but not fast enough to get obtain “escape
velocity.”

This is the reality of the world that we live in
today. If this three speed theory is correct then
there are three questions that must be answered:

Can it persist and for how long?

Will it add up?

What do you do about it?

Yes, it can persist but not forever.

The timing, which is tricky, differs on where you look. For
example, in Europe, Cyprus tells you much about the entire
European structure. The Troika is no longer operating in an
efficient manner. The creditors are also tired of supporting the
Eurozone as they see no end to the checks they are
writing.

Likewise, the debtors are tired from adjustment fatigue. The
problem is that the majority of Eurozone countries not only lack
growth but, much more importantly, they lack a growth model.

The financial markets don’t care because there is the
ECB. Whatever happens - the ECB, as Mario Draghi
promised last June, is willing and able to support them. However,
the ECB only supports the journey – not the destination. The
Eurozone is nearing the end of its journey and they will soon be
forced to make tough choices. They will be forced to
either opt for a stronger, and smaller, Eurozone which will begin
to grow again, or, fragmentation which will end miserably.

In the U.S. - the Fed is fully engaged in artificial support to
give the system time to heal. There is no question that the
economy is healing. Corporations, banks, and housing are all
healing. If this continues it will allow for a handoff from
supported growth to real growth. If the structural
problems don’t improve then we will slip back into a slow growth
economy.

Emerging markets will either continue surge or slip back to
moderate growth.

So, the reality is that when you live in an interdependent world
your competitors are your friends. In an independent world your
competitors can bring you down. The world, today, is unlike what
we have ever seen before. Unfortunately, global policy
coordination is really non-existent.

Historically, when the core has been weak there has been someone
to step in to support it. After WWII the U.S. stepped in to
support Europe. Today, with the entire world weak – there is no
one large enough to support the core.

When it comes to investing the majority of recommendations to
investors is not based on fundamentals but rather stocks are
cheaper than something else. This is potentially very dangerous.

What Should Investors Be Doing

Ride the central bank wave. The more intervention done by one
Central Bank forces other countries to do more. The Fed forced
Japan into its policy shift. Japan has now forced the ECB to move
further.

The Central Banks have little choice other than to continue on
their current trajectory. They cannot get to their objective
unless they make you feel better by boosting confidence.

However, it is also important to understand that all waves
eventually break. The question is whether you crash
or “walk off” the surf board. This wave will crash. When
it does it will depend on how you are positioned that will
determine whether you suffer or not.

Secondly, there are other waves out there. There are
too few people looking for other waves where central banks cannot
reach. In these areas there is genuine growth potential. These
include selected currencies, bonds and other types of assets.

Third, understand that past models are broken. The world today is
far different that it has been historically and therefore new
models must be built.

Fourth, you cannot disconnect the markets from the fundamentals
forever. There is a limit and when the reversion of
markets to the fundamentals occur the devastation to capital will
likely be severe.

Fifth, do not give up liquidity cheaply. In the world today it is
very binary. It will either end well, or very badly,
with no middle ground. Optionality and liquidity is the key to
surviving and profiting from a binary world.

Finally, realize that risk mitigation is going to have to
evolve. Cost effective tail hedging is going to be
critically important. This is a choice that all investors must
make: Do you leave some capital on the table as markets rise or
suffer large capital losses later. The choice is critical.

Conclusion

Why is it that the Pimco’s of this world are not disciplining a
system that is becoming more and more artificial? Why do we allow
the manipulation?

In a classroom you can discipline a single a person. However, if
the whole class misbehaves it is an entirely different
issue. Currently the whole class is misbehaving and
that is a very different paradigm than what we have seen in the
past which has led to unprecedented, unproven and untried
interventions that are likely to have far reaching outcomes.

Investors that are overly invested in stocks will eventually pay
a very high price for taking on excessive risk. We are
approaching the end of the journey for this experiment and it
will either result in a return to organic growth or economic
disaster. The problem is that we really don't know which it will
be. What we do know is that eventually, regardless of the outcome
of these monetary experiments, the disconnect between the
fundamentals and the markets will revert which will prove painful
for unhedged investors.